New Found Estate Planning Opportunities Following Ohio Estate Tax Repeal: Part 2

Effective for estates of decedents dying January 1, 2013, Ohio has repealed its estate tax. Long notorious for having the lowest estate tax exemption ($338,333) of the 17 states with estate taxes separate from the federal estate tax, this repeal provides an obvious and significant tax benefit. From a more technical perspective, Ohio estate tax repeal also has many opportunities to better accomplish a client’s goals. This second post in the series outlines the need to review prior planning used to zero out the Ohio estate tax to evaluate whether or not it is still needed and if so, how it can be improved to accomplish the client’s goals.

As already discussed in a previous post, trusts for Ohio residents are often designed to fund a Credit Shelter Trust (CST) with up to the Ohio estate tax exemption of $338,333. Excess trust assets then usually fund a marital trust designed to qualify for the Federal and Ohio marital deduction. Alternatively, many trusts for smaller estates may be drafted as single-fund QTIPs (also referred to as “one-pot” or partial election QTIPs) where all assets pass to a marital trust with the surviving spouse as the sole beneficiary while living and with mandatory distributions of income annually as well as other requirements to qualify the trust for both a federal and Ohio marital deduction if necessary. The executor then makes a partial QTIP election for both Ohio and Federal estate tax within 15 months after the decedent’s death as needed. Since the settlor usually intends the assets in this type of plan to be for the surviving spouse until his or her death this is an administratively convenient trust design as there is no need to actually fund the Ohio CST with $338,333 allowing only one trust for the surviving spouse but retaining the ability to minimize both Ohio estate tax and Federal estate tax if necessary. Yet another solution is a disclaimer trust where all assets distribute to the surviving spouse but drop into a trust for the survivor’s, and possibly others, benefit if the surviving spouse effectively disclaims the trust assets within nine months after the decedent’s death as required under IRC §2518.

All of these solutions can work well to provide fairly straight-forward tax planning around the low Ohio exemption but each has its limitations both before and after repeal of the Ohio estate tax beginning in 2013.

All of these solutions can work well to provide fairly straight-forward tax planning around the low Ohio exemption but each has its limitations both before and after repeal of the Ohio estate tax beginning in 2013. For example, mandatory funding of an Ohio CST creates a relatively small trust requiring separate accounting, specific funding and a separate annual fiduciary income tax return. After repeal, depending on the funding formula, it may not be funded at all or may be overfunded since it will no longer be capped at the Ohio exemption amount. As for the single-fund QTIP it still remains simple to administer both before and after repeal, but it wastes the ability to have a larger CST that does not leak income into the survivor’s estate for estate and GST tax purposes, does not provide the asset protection aspects of a discretionary trust and provides no flexibility when the settlor desires to benefit multiple beneficiaries. Lastly, the disclaimer plan works before and after repeal but to be effective, the survivor must be able to make a “qualified” disclaimer under IRC Section 2518 which means that (i) they must disclaim within nine months from their spouse’s death; (ii) they cannot use any of the assets prior to the disclaimer; and (iii) they may not have any power of appointment over the trust to which the disclaimed assets pass. This limits the control a survivor may have. Furthermore, with disclaimer planning it is often difficult to explain to a surviving spouse that they must “give up” something in order to save taxes and this technique is usually not a viable option in second marriage planning.

As an alternative to these common techniques, consider revising these types of trusts to be straight “bypass” style trusts for very small estates that will clearly be under the Federal exemption ($1,000,000 might be a safe bet for now, but could be as high as $3.5 Million or even $5 million once the fate of the federal estate tax is determined). This gives all the flexibility of a traditional CST without any of the restrictions of a marital deduction trust.

Another interesting alternative is the contingent, or “Clayton,” QTIP. This is a QTIP trust where the “all income interest” to the surviving spouse and other marital deduction requirements is contingent on the executor actually making a proper QTIP election.

Another interesting alternative is the contingent, or “Clayton,” QTIP. This is a QTIP trust where the “all income interest” to the surviving spouse and other marital deduction requirements is contingent on the executor actually making a proper QTIP election. Any portion of trust asset not subject to the election passes to a CST trust. This gives the executor up to 15 months to determine whether federal estate tax planning is required, allows the survivor access to the trust funds and does not limit the survivor’s powers over the CST after the election like a disclaimer plan does.

Contingent QTIPs have been around for some time, however, given the small Ohio exemption amount, it was usually not worth the trouble to use a contingent QTIP. Now with the Ohio estate tax gone, the Contingent QTIP may be worth another look. The following language could be added to a traditional marital trust:

“Reallocation of Assets Based on QTIP Election. Regardless of any other provision in this Agreement, if my Spouse survives me, and if there is a Federal estate tax in effect at my death, the provisions of this paragraph shall apply. In such event, I give to the Marital Trust only that fractional share of the Marital Trust as to which my Executor shall make the election under Code Sec. 2056(b)(7) (the “QTIP Election”). That portion of the Marital Trust otherwise determined under other provisions of this Agreement as to which my Executor shall not make the QTIP Election shall be distributed to the Credit Shelter Trust under this Agreement, to be disposed of under the terms of that trust.”

A Contingent QTIP may be a good solution to estates under the current federal estate tax exemption providing the benefits of trusts with flexibility in light of the uncertain federal estate tax and potential ease of administration and may be worth a look as you review and update estate plans in light of the repeal of the Ohio estate tax.

*this post is based on my upcoming article in the November/December issue of the Ohio Probate Law Journal titled “Ohio Estate Tax Repeal: The End or Just the Beginning? Unlocking Opportunities After Repeal.”